Thursday, September 30, 2010

Indian Microfinance Goes Public: The SKS Initial Public Offering

Dear Colleagues

The SKS Initial Public Offering (IPO) is going to be a big subject of debate in the microfinance sector for a long time to come. This is just the beginning.

I am glad to see the dialog ... but am concerned that the dialog is mainly between various sets of opinions, with many important facts missing. This happened with Compartamos in Mexico, and it is likely to happen again with SKS in India.

One day, I hope, The Burgess Method to assess socio-economic impact will help. Here is some of the dialog ... just the beginning!

Dear Microfinance Community,

CGAP http://www.cgap.org/p/site/c/home/ has just released a new focus note, "Indian Microfinance Goes Public: The SKS Initial Public Offering" which discusses this critical transition within the microfinance industry. http://www.cgap.org/gm/document-1.9.47613/FN65_Rev.pdf
The paper raises the question of what the IPO means for the future development of microfinance and for poor people and discusses key issues around the commercialization of microfinance.

In the coming weeks the series will feature a variety of voices from the industry with a new post every week. The first one, "6 Questions for SKS"http://microfinance.cgap.org/2010/09/28/6-questions-for-sks/ is by Stephen Rasmussen. Next week we feature Malcolm Harper. We welcome your participation through comments on the blog.

This post kicks off a special blog series on the SKS IPO. Over the coming weeks we’ll be featuring a variety of voices on the issues raised by the IPO. We welcome your participation in this discussion through comments.

A rare microfinance occurrence took place in late July this year. The Indian microfinance institution, SKS, became the second pure MFI globally to go public by listing its shares on the stock market. SKS is one of the largest microfinance institutions in the world with almost 6 million clients, mostly poor women living in rural areas. It has also been one of the fastest growing MFIs over the past few years, with a compound annual growth rate of 165% since 2004.

From one perspective, the IPO was a great success. It was 13 times oversubscribed, the company valuation reached the top of the offer band price (valuing the company at $1.5 billion), and the share price rose 42% in the first five weeks of trading. In the process SKS raised $155 million in fresh capital that will allow it to grow and serve far more people than it reaches now.

But for most of us, including those closely associated with SKS, evidence of real success will only come when we know if many more poor people have benefited. The purpose of the IPO was not just to access capital markets, but to access them to serve the interests of poor people.

The SKS IPO story is told in a CGAP paper published this week. The paper shares facts and asks questions about SKS and the IPO to stimulate discussion of this landmark event for microfinance.

For six weeks starting today, CGAP will host a special series on this blog representing the views of global microfinance leaders on the IPO. The series will reflect a diverse cross-section of views on the implications of the IPO and its influence on future direction of the microfinance sector.

It is clear that we have a long way to go from the estimated 100-150 million people accessing microfinance services today to reach the almost 3 billion un-banked people. Scaling up outreach to many more poor and un-banked people is the main goal for most of the microfinance world. Microfinance growth has often been and is still funded by governments, international donors, and socially minded investors. In addition, an increasing number of MFIs are able to mobilize deposits (though not in India) and borrow from commercial banks.

However, MFIs still say that one of the biggest constraints to growth is not having enough funding. What the SKS IPO shows is that MFIs can indeed harness the vast resources of capital markets. The initial success of the IPO raises the stakes for SKS. Some will celebrate this milestone event as opening up new avenues and opportunities for microfinance while others will be skeptical that the goals of profit seeking capital market investors can be compatible with the interests of poor rural women.

The CGAP paper describes SKS’s track record of establishing and trying to sustain a significant ownership share in SKS for the borrowers. This was done through the creation of shareholding mutual benefits trusts (MBTs) whose shares were valued at $220 million at the time of the IPO and are worth even more with the subsequent rise in the share price. The MBTs sold some of their shares after the IPO, realizing $42 million that will go back to the original SKS Society. The Society intends to build up a network of high quality schools to serve the children of SKS clients and other poor people.

But SKS will be watched closely for more than that.

Will SKS continue to focus on growth that reaches poor people who are not being served by others?

Will clients be better served by an expanding the range of services, higher quality services, and more affordable services?

Will the clients retain a strong voice in the affairs of the company to help it sustain a direction that serves their interests first and best?

Will shareholders understand that doing what is best for the customer is fundamental to sustaining long term shareholder value?

Will SKS’ social and financial performance help influence policies in India and globally in favor of greater financial access for more poor people?

And ultimately, will the lives of the many poor people SKS serves change for the better?

The SKS story still has a long way to go. What it does next will be closely watched by supporters and critics alike but it now has the opportunity and obligation to show the world that the poor can access capital markets to their advantage.

Stephen Rasmussen

The CGAP paper and the Rasmussen comment are a good launch pad for dialog about the SKS IPA and the Indian microfinance sector. From my perspective, the dialog will almost certainly lack a critical element ... the data about impact on the socio-economic condition of people at the Bottom of the Pyramid (BoP). The main metrics are about money ... the money viability of the institution. With an IPO, management must now pay attention to keeping investors happy with the earnings being reported.

Because much of the value associated with microfinance is to do with learning as much as it is to do with money credit ... making an MFI efficient usually reduces the learning component while improving profits ... good for stockholders but not so good for society.

Here is a comment from Ramesh Arunachalam. It is likely there will be many more!

From Ramesh S Arunachalam

Dear All

1. The growth and financial success of SKS and its IPO are well covered in the CGAP article , Indian Microfinance Goes Public: The SKS Initial Public Offering. The article is well written and the CGAP team needs to be complimented for this effort.

2. The financial success of the SKS IPO is indeed a heart-warming experience for all of (Indian) micro-finance. The fact that an MFI - with very modest beginnings - has, within a span of just 10 years, become, one of ‘the most valued’ financial institutions in India is indeed a very, very significant achievement. This is even more laudable when one considers the fact that much of what SKSML has navigated used to be pretty much, “uncharted terrain’’ for the Indian micro-finance industry. Without question, we should celebrate The SKS IPO event and the stupendous financial success it has achieved.

However, I would like to humbly place the following as my comments:

3. Despite the acknowledgement of the heightened importance of Corporate Governance, with humility, I would like to state that the CGAP article has not adequately addresed some of these crucial issues (already in the public domain - Prof Sriram’s article in EPW and other material) - which are an integral part of the phenomenal growth strategy of SKSML culminating in its IPO and subsequent listing. As these issues have very significant (future) implications for the orderly growth, development and commercialisation of the microfinance industry globally, I raise these issues here, as questions (not exhaustive) for CGAP to address, in the future:

a) Who authorized the lending of Rs 1.636 Crores (as an interest free loan) by SKSML to its founder to enable him to buy an equivalent number of SKSML shares at Rs 10 per share? Was it an individual at SKSML? Was it the board of SKSML? Was it the shareholders of SKSML? Under what powers was this related party transaction authorised? What is CGAP’s perspective on the process of approval and authorization from a best practices standpoint?

b) If it were the board of SKSML which authorized the transaction and/or approved the authorization provided by other stakeholders, who were the board members present when it (the SKSML Board) voted to give an interest free loan to its founder director to enable him to buy shares in the same company? Is this transaction an arm’s length one? Were there any conflicts of interest in the Board and were these declared? What are the implications of this and other related party transactions at SKSML for Corporate Governance in micro-finance? What will CGAP recommend in terms of safeguards against such potential conflicts of interest in MFIs?

c) How appropriate is it for a financial services institution like SKSML – especially, one that is meant to service poor clients - that had significant public money (SIDBI’s investments) and client money (MBTs), to lend (interest free) to its own founder director to buy shares in the same company? Is this a good practice of Corporate Governance? Should this be allowed in MFIs? Would the investors and donors who are part of CGAP recommend this practice of MFI owners lending to themselves to buy their own (MFI/company) shares as a good practice? Would investors/banks who are investing/lending to MFIs recommend this as good practice? What is CGAP’s position on such related party transactions in micro-finance, especially from the perspective of best (good) practices paradigm that CGAP has been prescribing (over the years) in micro-finance?

d) What was the consequent impact of the above related party transaction on the financial condition of SKSML, the MFI? Did it result in a misstatement of the true financial condition of SKSML? If so, have the shareholders been (mis)informed? What are the implications of this under the various Indian laws including the Indian Penal Code and other acts as may be appropriate? In CGAP’s opinion, from a good practices perspective, in case of such related party transactions, should adjustments be done by MFIs to reflect the true financial condition? If so, what methodology should the MFIs follow and how should they present the results?

e) Can this action taken by the Board of SKSML (in which public institutional investors and MBTs held significant shareholding) be termed as one that was in the interest of the shareholders, especially the minority shareholders? While the MBTs held a lot shares in aggregate, in reality, they were individual shareholders and therefore are best considered as minority shareholders. Who on the board protected the interest of these minority shareholders? In CGAP’s opinion, was this transaction in the interest of the minority stakeholders – i.e., members in MBTs? In CGAP opinion, what should be done to protect the interests of such minority stakeholders in the future? This is a very critical question indeed.

f) Were there nominee directors of the institutional investors on the board of SKSML when this happened? If so, how did they react to this and/or even permit this? What were they doing on the Board of SKSML, when norms/rules of Corporate Governance were seemingly not followed? Did they object or express reservations on this related party transaction and other such happenings? If so, did they inform the institutional investors officially of the happenings? If they were silent, was there any conflict of interest? How did they make themselves accountable to the institutional investors for being their nominee director, safeguarding their investment and (public) funds? What are CGAP’s suggestions for enhancing the accountability of the nominee directors – both in terms of the reporting to be done by them and also the processes to be followed by investors while appointing them?

g) Institutional investors have the moral and legal responsibility to ensure that such CORPORATE MIS-GOVERNANCE does not occur, at least, in MFIs/companies where they have made investments and where they also have a responsible officer as a nominee on the Board. In the present case, did the institutional investors have any procedure to review the performance of their nominee directors and/or the functioning of the Board in MFI where investments had been made? In CGAP’s opinion, what safeguards should be built to ensure that nominee directors really act in the interest of their investors, while upholding the highest standards of Corporate Governance?

h) Given that some MFIs in India (there are a few of them who have done this to a varying degree) are in habit of lending to their own directors (and none of these can be described as an arms-length transaction) to buy their own shares, are they eligible for priority sector lending funds (PSLF)? Is this practice of lending to directors (to buy own company shares and for other reasons) in consonance with norms for PSLF? What are the implications for Policy in India? What is CGAP’s position on use of PSLF and what are its prescriptions for policy in India regarding the same?

i) It has been publicly mentioned by SKSML in an advertisement dated July 28th July 2010 that the (related party) transaction of the company lending to its own founder director to buy shares in the same company does not represent a violation of the Company’s Act and RBI circulars. Is this true and particularly, when one considers the Indian Penal Code (IPC) under which other companies have been implicated for presentation of wrong information to shareholders? What is the actual position of policy (RBI, Ministry of Corporate Affairs, Ministry of Finance and other relevant authorities in India) on this, especially in the wake of the global financial crisis and Satyam Fiasco? What are CGAP’s suggestions to Indian policy makers, as per its good practices paradigm, on the aspect of dealing with such related party transactions in micro-finance?

j) Several concerns were raised with compensation aspects and process of allotment of shares at SKSML. Much of this material is already in the public domain (Prof Sriram’s article, SKS rejoinder to Prof Sriram’s article sent via Sa-Dhan by e mail and other documents). There are several issues here and it would have been useful to have CGAP’s input on whether the compensation and allotment processes followed at SKSML were indeed transparent, as per good practices norms and also legally correct:

i. Regarding the process of allotment of shares at SKSML, it would be good to know what was approved: a) in the board, and b) by the Shareholders, and compare the same with filings done with ROC (Registrar of Companies). Documents in the public domain seem to indicate discrepancy;

ii. It appears that all approvals were provided for ESOPs to be issued to the founder and others (like COO) in Feb’07. However, in reality, it seems that ESPS (Shares) were issued to the COO and Shares were issued to the founder. The question here is how could this be done when the approval was for ESOPs – Stock Options? Therefore, a clear understanding on the above, whether there are any discrepancies, would be required, especially in view of the fact that shares allotted to founder had already been fully sold out before the IPO while those given to the COO had been partially liquidated;

iii. Regarding the ESPS, it appears that the Company had a scheme where employees would be issued shares when they join, which are to be vested over a period of 4 years. The company was to give a loan to trust, which was to lend the same money to Employee to buy these Shares. In turn, the employee would enter into financing arrangement with Trust and also the Company. Under this, the Shares would be directly either freshly allotted to the Employee or if there are any shares in the Pool available, they would be transferred to the Employee’s name. This arrangement of giving any amount of Loan and allotting or transferring the Shares directly in the name of the Employee appears to be in contravention of Section 77 (3) of the Companies Act. As per this section, Shares cannot be allotted in the name of the Employee directly and also the Loan amount CANNOT exceed 6 moths salary of the Employee. Prima facie, it appears that the company was violating the above conditions;

iv. There seems to be reasonable evidence to the assertion made in Prof Sriram’s paper that at a time when the company was attempting to enter the primary market and tap retail investors, the founder INDEED held ZERO equity, and it is his unexercised options, that were subjected to a 3 year lock-in period. In fact, in the DRHP table, the founders name is not there under the Promoters group and some of the key employees were selling off their exercised options, before the IPO; and

v. There appear to be several other issues including the following - that the vesting period for some schemes were not satisfied, specific schemes were perhaps SEBI non-compliant and high bonuses had been granted to senior management.

vi. Therefore, it would have been appropriate if CGAP had looked at these issues and developed some lessons for MFIs on how to tackle compensation aspects (including composition and role of compensation committee) from a good practices perspective. CGAP’s comments on one of the key aspects in the compensation debate – i.e., whether the process and outcomes related to compensation are in line with the long-term risk inherent in the (MF) financial services business – would also have been extremely useful from an industry wide perspective.

k) It should be noted that after the IPO, Dr Vikram Akula became the executive chairman of SKSML and Mr M R Rao became the deputy CEO. It appears that key people and positions are being changed in the SKS group of institutions at will – one day, there is a trust with several members looking after the interest of the MBTs, then, another day, most members of the trust resign and there are just two people including the founder. The founder then suddenly becomes the executive chairman, post IPO. Just as I was finishing the note, there was an announcement from the Bombay Stock Exchange that SKSML had terminated the services of Mr Gurmani, its CEO, whom it had appointed for a period of 5 years from 2009.

This again raises serious questions about the effectiveness of corporate governance at SKS and the market did react, with SKSML shares going DOWN by almost 5.81% at around 3.20 PM on October 4th 2010. Therefore, it would be useful to get CGAP’s opinion, on the frequent and sudden changes in the Board and Senior Management structure of SKSML and related institutions, from a corporate governance perspective and provide lessons for the MFIs, which are indeed nascent when it comes to maintaining their valuations in the primary market. These lessons should also be invaluable to peer MFIs, even as they prepare themselves to tap the primary market.

4. Last but not the least, I would like to make the point that, ‘commercialisation of micro-finance is a very necessary trend and this critique of the CGAP SKS article should not be taken as an argument against commercialisation. However, to be welcome, commercialisation must be executed in a proper and legally correct manner. Without question, the means are as important as the ends and only commercialisation that is achieved through legally correct methods and means, should be supported - as that alone can have a positive impact on people with low income’.

Thanks. Regards.

Ramesh

This post was appreciated by other readers as well as myself. For example:

Dear Shri Ramesh,

I am extremely happy to read your very objective analysis of SKS IPO which could not be done by even an international organization like CGAP. We need to have such objective and pragmatic studies to assess the challenges and opportunities of MFIs to contribute successfully for inclusive growth in true sense.

Regards

Dr.S.N.Ghosal

The microfinance industry knows there is a metrics challenge ... but in the main the initiatives to address this have added more detail and more work without gaining much more information about community impact.

My own position is that performance depends very much on many externalities that have to be measured in order to have any meaningful understanding of performance. Each community is different ... averages are always going to be wrong!

About Me

Read engineering and economics at Cambridge ... qualified as a Chartered Accountant ... professional and corporate management working on management information and metrics of performance. International assignments as CFO and then as consultant to World Bank and UN agencies in connection with development projects and emergency situations. Work on planning at the national, area, sector and community level. Appalled at the current state of financial reporting in the corporate world and the metrics that drive major decisions in both the corporate and political sphere! The development of Community Analytics (CA) is a response to the need for better metrics than merely money accounting ... the concept of value should be treated with equal rigor and sophistication!